- Macro Strategist
Singapore, Individual
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Asia will likely record the world’s strongest growth this year and next, primarily driven by China’s recovery. Factors such as emerging structural change in Japan, accelerating tourist flows across the region, and a pro-growth environment in India are likely to provide further support. Post-COVID consumption is central to this growth, with households still having large excess savings accumulated during the pandemic. Financial conditions should remain supportive given muted inflation pressures and relatively stable currencies.
China — a service-led recovery
China’s reopening is underpinning this positive scenario, yet sentiment is poor among investors in Chinese markets, both domestic and overseas, as evidenced by attractive equity valuations. Onshore equities (A-shares) are currently trading near the bottom of their 10-year range while offshore equities have reached their cheapest levels in two decades.
While it is hard to pinpoint the exact causes of this pessimistic view, it is likely driven by disappointment that we are not seeing a repeat of the 2009 boom and heightened geopolitical tensions. Yet economic data has been mostly solid and, as a macro team, we expect the economy to remain robust through the year, with economic indicators and earnings beating expectations.
Since the removal of COVID restrictions, the service sector has resumed its upward trajectory ahead of manufacturing and offers a long runway for growth. The switch from manufacturing to service sector leadership (Figure 1) over the medium term is a natural trend as economies develop. Moreover, as elsewhere, services were more heavily impacted by COVID restrictions given the need for personal contact. Consequently, while our estimates suggest that manufacturing has nearly returned to pre-COVID trend levels, the service sector is still 10% down.
Figure 1
Longer term, rising incomes also support service-related consumption, with consumers increasingly willing to pay a premium for quality.
Losing steam?
Markets have interpreted recent weaker data as the Chinese growth engine running out of steam, but we believe this is an overreaction as, in our view, the foundations for China’s rebound are solid. However, the pace of this domestic-orientated service recovery will be slower than the previous export-led growth spurt. The gradual rebooting of the Chinese economy also reflects the severity of the COVID shock, and the uncertainty caused by political and regulatory developments. Reestablishing confidence among consumers and businesses will inevitably take time.
Another area of concern is the extremely high level of youth employment (almost 20%). While unwelcome, it does not necessarily imply a deteriorating economy. We point to three factors at play:
- Youth unemployment tends to be structurally higher.
- A recent bulge has occurred in the youth population, after years of structural decline.
- Trends in educational attainment and high savings among families have enabled jobseekers to become more selective and hold out for their white-collar job of choice.
Markets also worry about the sluggish state of the large property sector and its impact on the broader economy. Yet real estate is not as significant for China’s GDP as is often assumed, a misperception created by the nonstandard way in which China accounts for property in its GDP calculations. Current weakness reflects still fragile sentiment, but it also suggests progress in the structural adjustment of the sector.
On the plus side, inflation is not an issue and unlikely to become so over the next 12 to 18 months. Monetary policy remains largely conservative, with no expansion in the central bank’s balance sheet and nominal interest rates above inflation. Monetary tightening is unlikely to be needed near term as core inflation appears well contained, while headline numbers are collapsing with the reversal of commodity prices.
China’s currency also remains supported by its current account surplus (near-record in US dollar terms) and while this surplus is likely to narrow as international travel resumes, the country will remain the world’s largest net foreign creditor.
Two key risks
We see two important risks for our market outlook:
- After a short pause, tensions between the US and China have started to ratchet up again. The internal political climate in both countries complicates any thawing of relations in the near term. Heightened scrutiny of foreign firms operating in China and potential restrictions on outward investment from the US to China could be areas of further friction.
- Climate risks are increasing. Record temperatures and lack of precipitation have hampered the replenishing of reservoirs that provide hydroelectric power in parts of China, raising the risk of renewed power shortages this summer, which could hurt industrial production.
Growth across Asia
We expect growth across Asia to continue apace, with China as the pivot. As in 2022, we expect developing Asia to be a key beneficiary of this trend (Figure 2), especially those countries with large tourism sectors. For instance, Thailand, whose tourism industry accounts for 30% of GDP, could see traveler inflows double or even triple. Indonesia, Vietnam, and Malaysia are also well-positioned to take advantage of the structural diversification of supply chains away from China. In parallel, they are also attracting a significant amount of inward investment from Chinese companies looking to tap into the large and growing consumer markets of Southeast Asia.
Figure 2
Elsewhere, India’s economy is buoyed by strong investment demand, with its government both investing public money and facilitating private sector participation.
Among developed Asian economies, Japan and South Korea are also set to benefit from China’s reopening, notably through visitor flows that will support consumption. Both countries are also likely to profit from a robust electronics cycle as well as positive developments in their domestic economies: in the case of South Korea, a rebound in the housing sector; and for Japan, the emergence of positive structural changes that could help inflation take hold.
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